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Small Business Accounting:
Projecting and
Evaluating Performance
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Why Accounting Matters
• Proves what your business did financially
• Shows how much your business is worth
• Banks, creditors, development agencies, and
investors require it
• Provides easy-to-understand plans for business
operations
• You can’t know how your business is doing
without it
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• Three types of accounting:
– Managerial accounting: used by managers
for planning and control
– Tax accounting: used for calculating and
reporting taxes
– Financial accounting: used by banks and
outside investors
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Basic Concepts
• Business entity concept: a business has an
existence separate from that of its owners
• Going concern: business is expected to
continue in existence for the foreseeable
future
• Accounting equation: assets = liabilities +
owner’s equity
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• What is a cost? What is an expense?
– Costs: real changes in what you own
– Expenses: entries made in your accounting
system to record your use of goods and
services
– Managerial accounting is focused on
predicting the future, so it uses expenses
only for budgeting and planning purpose
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• Information usefulness: must be
accurate and relevant
– Only two reasons to do accounting:
• To produce information that is useful to you
for managing your business
• To meet legal or contractual requirements
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• Computerized accounting: most
commonly used (QuickBooks,
Peachtree)
– Systems should easily accomplish:
•
•
•
•
•
•
Easy-to-understand user interface
Context-sensitive help function
Income statements
Classified balance sheet
Development of a cash budget
Produce financial statements
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Example
Which Accounting Software is Best for You?
• Two main types of accounting software:
– industry specific and generic
• Consider the following for choosing a package:
–
–
–
–
–
–
–
The size of your business
The industry you're in
The components you need
Available support
Financial resources
Professional recommendations
Ease of use
http://www.entrepreneur.com/money/moneymanagement/financialmanagementcolumnistpamnewman/article166216.html
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Setting Up an Accounting System
• Accounting functions:
– Accounts payable
• Payroll
– Fixed asset
– Inventory
– Credit card sales
– Accounts receivable
– Insurance register
– Investments
– Leasehold records
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Financial Reports
• Five common financial statements:
– Income statement
– Statement of retained earnings
– Statement of owner’s equity
– Balance sheet
– Cash flow statement
• Important thing is that the information flows all the
way from the income statement to the balance
sheet
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• Income statement: primary source of
information about a business’ profitability
– Revenues – Expenses = Net income
– Difficulties in understanding the income
statement
• Disagreements about what exactly should be
reported as revenue
• Disputes over when to recognize revenues
– Most small business do not have problems
with these; sales are cash, or the same as
cash
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• Balance sheet: “Statement of Financial
Position”
– Snapshot of financial holdings and liabilities
at the close of business on a specified date
– Minimum detail is to report assets and
liabilities in two categories: Current and
Long-term
– Used to determine the liquidity, financial
flexibility, and financial strength of the
business
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• Balance sheet: cont.
– Limitations:
• All values listed are historical values
– Value recorded in the accounting records
can be widely different from the asset’s
current value
• Balance sheet might not completely reflect
the business
• Certain assets and liabilities are omitted
from the balance sheet
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• Cash flow statement: sources and uses
of cash by the business
– Cash flows from operating activities
– Cash flows from investing activities
– Cash flows from financing activities
• Net effect of foreign exchange rates
• Net change in cash balance during the period
• Non-cash investing and financing activities
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Example
Building a Financial Budget
• Business budgeting is one of the most powerful
financial tools available
• Most effective financial budget includes both a
short-range month-to-month plan for at least a
calendar year and a quarter-to-quarter long-range
plan you use for financial statement reporting
• It is important to budget both the income statement
and balance sheet
http://www.entrepreneur.com/money/moneymanagement/financialanalysis/article21942.html
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• Financing activities: actions taken by
management to finance the operations of
the business
– Net effect of foreign exchange rates: rates
often vary rapidly
– Net change in cash balance: reconciles the
net increase and decrease with the
beginning balance
– Non-cash investing and financing: exchange
of value other than cash takes place
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Financial accounting can be a highly
valuable aid in decision making
•
•
•
•
•
Reporting to outsiders
Record keeping
Taxation
Control of receivables
Analysis of business operations
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• Managerial accounting techniques will
make you a better small business
manager
• More accurate at forecasting profits,
planning operations, and conserving
scarce resources
• Managerial functions:
– Planning, organizing, staffing, directing, and
controlling
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• Cost-Volume-Profit analysis: technique
which looks at the fixed and variable
costs of a business to arrive at a number
of unit sales (volume) to maximize profits
• Variable Costs: costs that change with
each unit produced
– Raw materials
• Fixed Costs: costs that remain constant
regardless of quantity of output
– rent
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• Breakeven Point : point at which total
costs equal total sales
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Business Plan and the Budget
• Business plan: specifies the amounts and types
of inputs required to achieve a set of desired
outcomes
• Based on assumptions:
– How risks can be controlled
– What opportunities can be taken
• Budgets have the advantage of being
comprised of a series of small schedules
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• Planning / budgeting: process through
which strategy is mapped into a series of
tactical and operational actions
– Budget becomes a standard against which
performance can be measured
– Basis for controlling activities and the use of
resources
– Few small business owners consistently
budget
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• Sales budget: projected future level of
sales in units multiplied by the sales price
per unit
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• Purchases budget: number of units that
are expected to be acquired during the
budget period
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• Cost of Goods Sold Budget: predicted
cost of product actually sold during
accounting period
• Labor budget: amount and cost of labor
needed to meet required production
– Assume that labor can easily be increased or
decreased
– Can easily be modeled as a fixed cost
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• Manufacturing overhead budget: usually
treated as fixed costs
– Becoming more common for managers to
use activity-based cost estimates for
overhead
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• Selling, general, and administrative
budget: SG&A, contains both costs that
change with production and costs that do
not
– Advertising and freight are variable costs in
respect to sales
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• Budgeted income statement: budgets
that have been completed to this point
are combined into pro forma financial
statements
– Common to create the statement in only a
fiscal year format
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• Completing a comprehensive budget:
– Final processes to be accomplished to
produce a complete master budget
•
•
•
•
Budgeted cash receipts
Budgeted cash payments
Cash budget
From these statements, prepare:
– Pro Forma projected balance sheet
– Pro Forma projected cash flow statement
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• Controlling:
– Managerial accounting provides
information that allows managers to
determine how well the business is doing
in attaining its goals
– Variances should be evaluated to
determine the significance; they occur
due to one of these events
• Prices are different from what was
estimated
• Quantities are different from what was
estimated
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Decision Making
• To make good decisions, you need:
– Good information
– Efficient ways to condense information
– Methods to help compare alternatives
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• Managerial accounting is both a source
of information and a methodology to
reduce the complexity of the information
• Accounting is useful for:
–
–
–
–
Managers of small businesses
Record keeping
Reporting to absentee owners
Substantiating assertions made to regulators
and taxing agencies
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